No spousal rollover where beneficiaries assign rather than disclaim RRSP

At issue

When a person dies, RRSP holdings are generally brought into income in the deceased’s terminal tax year.  However, where there is a beneficiary designation to a spouse (or certain dependents), a tax-deferred refund of premiums enables a rollover to the recipient’s RRSP.

Alternatively, the RRSP may be paid into the estate if there is no valid designation in place, or if the estate itself is named as beneficiary.  Either way, it is possible to make a joint election with the estate to effect a similar rollover, assuming the spouse or other qualified beneficiary has sufficient entitlement in the estate.

IT-500R Registered Retirement Savings Plans – Death of an Annuitant (Archived) 

This interpretation bulletin (now archived) includes CRA’s past guidance on dealing with RRSP rollovers.  (Such bulletins are administrative only, and specifically are not binding legal authorities.)

It includes reference to RRSP joint elections between an estate and a spouse, and the potential to use them when other beneficiaries have disclaimed their interests in an estate.  This requires that the spouse’s estate entitlement is at least the value of the RRSP, and is not available if the spouse is only entitled to a portion of the RRSP or if under an intestacy the spouse only receives specific assets other than the RRSP.

There is no discussion of the effect of a named beneficiary of an RRSP disclaiming such interest.

Estate of the late John Arthur Murphy v. Her Majesty the Queen, 2015 TCC 8 

John Arthur Murphy died in Nova Scotia in 2009.  Despite owning a home, farm property, forest properties, rental properties, cottages and livestock, he had no Will – His estate was an intestacy.

Mr. Murphy’s heirs were his spouse Barbara DeMarsh and three adult children from a previous marriage (“the Murphys”).  There were ebbs and flows in the dispute that followed, including claims under matrimonial and intestacy law.  Eventually a Consent Order was filed with the court in May 2011, providing (among other matters) that the Murphys take all necessary steps to “release, convey and transfer to and in favor of [Ms. DeMarsh] any and all interests that they may have in” an RRSP worth $237,026, on which they had been the named beneficiaries.

The particular RRSP had been reported in Mr. Murphy’s terminal tax return, filed in April 2010.  To give effect to the agreement and enable a rollover to an RRSP with Ms. DeMarsh as annuitant, the estate requested a T1 adjustment in August 2011.

The CRA denied the request, leading to the present appeal in which the estate argued that the Consent Order had the effect of indefeasibly vesting the subject RRSP in Ms. DeMarsh retroactive to the time of Mr. Murphy’s death.

The judge disagreed.  A disclaimer is a refusal to accept a gift, after which the disclaiming party has no right to direct who is to receive the gift.  In this case, the Murphys did not disclaim their interest in the subject RRSP, but rather they settled the litigation by transferring their interest in the RRSP to Ms. DeMarsh.  In the judge’s view, the settlement “is not a disclaimer but an assignment.”

The RRSP proceeds remained as income to the estate, with no refund of premium allowed to roll over to an RRSP for Ms. DeMarsh.

Practice points

  1. Mr. Murphy’s lack of a Will (and the resulting intestacy) contributed to uncertainty and delay generally, and arguably factored into the substance of the outcome.
  2. The settlement dealt with assets and issues well beyond the subject RRSP, including contingencies like the potential that the T1 adjustment might be denied.  While the judgment rested at least in part on the text of the settlement, the chosen words may have been necessary to preserve the broader agreement.
  3. Though not discussed in the case, generally RRSP rollovers must occur by December 31 of the year following death.  Had the estate been successful on the core issue, it may still have faced a hurdle on this administrative requirement.

Paying small business corporation dividends – Federal budget may be a call to action

One of the surprises in this year’s Federal Budget was the announced increase in the small business deduction for corporations.  Or in more common language, the small business tax rate is coming down.

This will be welcome news to small business owners who will benefit from being able to reinvest more of their after-tax dollars within their corporations.  While this is a win in the context of required reinvestment for business purposes, the effect is not so clear where it is a discretionary decision to forego dividends and invest to earn passive income.

And beyond that, this development could cause a reconsideration of existing investment accounts held at the corporate level.  Continuing to hold these funds in the corporation could result in the shareholder paying up to 2% more if dividends are delayed beyond this year.

Small business tax adjustments

The small business rate on the first $500,000 per year of qualifying active business income of a Canadian-controlled private corporation (CCPC) is going down from 11% to 9%.  The reduction will be implemented in half-percentage point in stages from 2016 to 2019.

In turn, corporate income that has benefited from the small business rate is treated as a non-eligible Canadian dividend when paid out to the shareholder.  To maintain balance for the integration of corporate and personal taxes, the gross-up and dividend tax credit (DTC) for non-eligible dividends will also be adjusted. (See table.)

These are changes at the federal level.  However, as the same gross-up is applied when calculating the shareholder’s provincial tax on the dividend, one would expect provinces to adjust their dividend credit rates accordingly.

Federal small business tax adjustments

                                                      2015        2016        2017        2018        2019

Small business rate              11%      10.5%        10%        9.5%          9%

Gross-up                                 18%         17%        17%         16%        15%

DTC                                            11%      10.5%       10%         9.5%         9%


Implications for dividend policies

In a given year, a shareholder (as director) may declare a dividend out of retained earnings, or continue to retain such funds in the corporation.  All else being equal (so the saying goes), the shareholder portion of income tax is deferred by retaining those funds corporately.  However, all else is not equal as we come into 2016 and roll through the next three years.

Consider a corporation that earns income in the current year, paying the 11% small business rate (focused on federal portion only).  On dividend of those funds in the current year, the DTC will be an equivalent of 11%.  However, if the dividend is delayed one year to 2016, the DTC will be the reduced 10.5%, meaning corporation and shareholder bear an extra 0.5% tax.  And of course that becomes as much as 2% if one delays to 2019.

This adds a wrinkle to the dividend/retention decision this year and in the next three years, though of course it is for the particular business owner to decide whether it is material. An obvious tradeoff arises if current dividends push the shareholder up through marginal tax brackets.

With respect to existing corporate investment accounts, the need for a decision is arguably more pressing.  This is retained money that has already paid its corporate tax, and has essentially been waiting to be subject to personal tax on dividend to shareholder.  As the corporate investments are likely part of eventual retirement, an early withdrawal may be undesirable, even in the face of this additional tax cost.   On the other hand, the reduction of the gross-up from 18% to eventually 15% will mean that later dividends will have less of a clawback effect on income tested benefits.

A thorough review will be necessary to determine the net effect on a given business owner.  And to repeat, it remains that person’s prerogative whether this is sufficiently material to take action.

Estate as the designated beneficiary – An estate-planning lawyer’s perspective

“Make sure to designate a beneficiary on RRSPs, RRIFs and TFSAs so the money doesn’t fall into the estate.”

It’s such familiar guidance in investment and financial planning that it would be foolish to suggest otherwise. Or would it?

I recently had an exchange with a financial advisor whose client’s lawyer recommended the estate as the named beneficiary. It was a young family with a single child and nothing else remarkable.

Unusual though that recommendation may appear, I myself offered the same advice to some of my clients in my past estate-planning law practice. Then as now, beneficiary designations help bypass probate tax and estate creditors, but may be cast in a different light when considering the following countervailing points. [See Callout Box on Quebec below]

Tax onus on registered retirement savings plans (RRSPs)/registered retirement income funds (RRIFs)

A person named directly as beneficiary is entitled to the gross value of an RRSP/RRIF, with the tax liability falling to the estate. Though the named beneficiary has a joint liability under the Income Tax Act (Canada) for the proportionate amount of the estate’s tax, the Canada Revenue Agency would likely only bother pursuing such a course if the estate is insolvent. There is no provision for the estate itself to claim contribution from the RRSP/RRIF beneficiary.

This would not be an issue where the beneficiary/ies of the RRSP/RRIF and the estate are identical, but could be a serious concern in a situation such as a second marriage, whether on first or second death of spouses.

Flexible spousal rollovers

It may be desirable to have RRSP/RRIF proceeds come into an estate in order to take advantage of a deceased’s graduated tax brackets, rather than have an immediate rollover to a spouse. This could be particularly effective if the death occurs early in the year (i.e., there is little other income). Otherwise, the RRSP/RRIF simply adds on to the surviving spouse’s own registered funds, with potentially higher future tax cost to fully deplete (whether in life or at death).

Generally, the estate and surviving spouse can still elect to roll the excess (not included in the estate) to the spouse.

Amending and revoking

The Will gathers all beneficiary designations together in one place, centralizing control through that one instrument. Otherwise, the person would have to deal with the administrative rules, paperwork and potential delays in dealing with each financial institution. It remains that person’s prerogative to amend/revoke the Will, with the requirements of testamentary capacity being the same for a Will as for beneficiary designations.

On divorce (though not necessarily on separation), spouse entitlements in a Will are generally revoked (although this may vary by province) without having to execute a new Will. On the other hand, designations with financial institutions are not automatically revoked, even in the face of apparent explicit terms in an executed separation agreement. In fact, there is plenty of case law where this has been fought. (Even so, one should be tactful if raising this point with spouse-clients who are otherwise presently in wedded bliss.)

Inheritance contingencies

Trust terms in a Will can be tailored for later issue/grandchildren, whether as additions to the distribution or as stand-ins for one or more predeceasing directly named beneficiaries. For beneficiary designations, the default is generally that if AB, CD and EF are RRSP/RRIF beneficiaries and AB predeceases, CD and EF share equally under survivorship. That may not be the satisfactory expected result if AB has children whom the deceased would have wished to include.

If a target beneficiary has creditor and or matrimonial concerns (presently or as caution against future developments), trust terms may be attached to insulate against that exposure.

For spendthrift concerns (e.g., gambling, drinking, profligate), trust terms could be laid out, maybe to establish a short- or long-term allowance rather than a lump sum.

Transfers to minor beneficiaries or disabled beneficiaries will likely not be adequate as direct beneficiary entitlements, and may be detrimental in terms of impairing provincial support amounts (for the disabled), limiting investment options (requiring an annuity to age 18 for minors), losing control of distributed monies, and likely requiring consultation/approval of government authorities.

Estate liquidity

Absent cash in the estate (e.g., it consists solely of a house and other non-monetary assets), it may require someone to post the funds for the probate tax (to be eventually reimbursed) in order for the executor to take control of the estate assets and begin realizing on them.

Inter vivos or testamentary trust?

As a final thought, an estate is a testamentary trust that is taxed using graduated brackets. Assuming a principal beneficiary (e.g., a surviving spouse) is at a higher bracket than the estate, the cost of probate may be effectively negated by lower taxes on income generated from estate investments. In the past, this could potentially be carried on for many years, but after 2015 will generally only be available for the first 36 months of the estate.

Another alternative may be to have designations directed to a trust that is separate from the estate, with the result that probate and creditor concerns may be circumvented. The lost use of the estate’s graduated brackets should be factored into this latter approach, perhaps by directing some of the RRSP/RRIF proceeds to the estate or by providing the trustee with power to disclaim entitlement to some extent, in order to allow such RRSP/RRIF funds to fall into the estate.

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Callout Box – Quebec residents

Based on a Supreme Court of Canada ruling in 2004, financial institutions generally will not accept beneficiary designations by Quebec resident annuitants, forcing such registered plan proceeds to fall into the deceased’s estate.  While a Will is a key planning tool for all Canadians, the mandatory involvement of the estate for registered plans in Quebec reinforces this need, and underlines the considerations expressed in this article.